Accounting for Investment Banking Interviews: The 20 Concepts You Must Know

You don't need an accounting degree to break into investment banking.

But you do need to understand how financial statements work. How the income statement connects to the balance sheet. Why depreciation matters for valuation. What happens when a company takes on debt.

Interviewers test this constantly. Not because bankers are accountants—but because accounting is the language of business. If you can't read financial statements fluently, you can't value companies.

This guide covers the 20 accounting concepts that actually appear in interviews. Not exhaustive accounting theory. The specific knowledge you'll be tested on.

The Three Financial Statements

Before diving into concepts, understand the big picture.

Income Statement

Shows profitability over a period of time (quarter, year).

Key line items:

Revenue (sales)
Cost of Goods Sold (COGS)
Gross Profit
Operating Expenses (SG&A, R&D)
Operating Income (EBIT)
Interest Expense
Pre-Tax Income
Taxes
Net Income

What it tells you: Did the company make money during this period?

Balance Sheet

Shows financial position at a point in time.

Key sections:

Assets (what the company owns)
Liabilities (what the company owes)
Shareholders' Equity (the residual for owners)

Fundamental equation: Assets = Liabilities + Shareholders' Equity

What it tells you: What does the company own and owe right now?

Cash Flow Statement

Shows cash movements over a period of time.

Three sections:

Cash from Operations (CFO)
Cash from Investing (CFI)
Cash from Financing (CFF)

What it tells you: Where did cash come from and where did it go?

Concept 1: How the Three Statements Link

This is the most common accounting interview question. Master it.

The Connections

Income Statement → Balance Sheet:

Net Income flows to Retained Earnings (in Shareholders' Equity)

Income Statement → Cash Flow Statement:

Net Income is the starting point for Cash from Operations

Cash Flow Statement → Balance Sheet:

Ending Cash on the Cash Flow Statement equals Cash on the Balance Sheet

Balance Sheet → Cash Flow Statement:

Changes in working capital accounts affect Cash from Operations
Changes in PP&E affect Cash from Investing
Changes in Debt and Equity affect Cash from Financing

Interview Question: Walk Me Through How the Three Statements Connect

Strong answer:

"The three statements are interconnected in several ways.

Starting with the Income Statement: Net Income flows into the Balance Sheet through Retained Earnings. If a company earns $100 in Net Income and pays no dividends, Retained Earnings increases by $100, which increases Shareholders' Equity by $100.

Net Income also starts the Cash Flow Statement. We begin with Net Income, add back non-cash charges like depreciation, adjust for changes in working capital, and arrive at Cash from Operations.

The Cash Flow Statement connects back to the Balance Sheet. The net change in cash from all three sections—operating, investing, and financing—equals the change in the Cash line on the Balance Sheet.

Finally, many Balance Sheet changes flow through the Cash Flow Statement. If Accounts Receivable increases, that's a use of cash in CFO. If the company buys PP&E, that's a use of cash in CFI. If the company issues debt, that's a source of cash in CFF."

Concept 2: Depreciation and Amortization

Depreciation is everywhere in accounting and valuation. Understand it cold.

What It Is

Depreciation: Allocates the cost of tangible assets (buildings, equipment, vehicles) over their useful lives.

Amortization: Allocates the cost of intangible assets (patents, software, customer relationships) over their useful lives.

Why It Exists

When a company buys a $10 million machine, it doesn't expense $10 million immediately. That would distort profitability—the machine will generate revenue for years.

Instead, the company capitalizes the asset (records it on the Balance Sheet) and depreciates it over time (expenses a portion each year on the Income Statement).

How It Flows Through Statements

Income Statement: Depreciation is an expense that reduces Operating Income and Net Income.

Cash Flow Statement: Depreciation is added back in Cash from Operations. Why? Because it reduced Net Income but didn't actually use cash—no check was written for "depreciation."

Balance Sheet: Accumulated Depreciation increases, reducing the Net PP&E balance.

Interview Question: A Company Buys a $100 Piece of Equipment. Walk Me Through the Impact on All Three Statements.

Strong answer:

"At purchase, assuming the company pays cash:

Income Statement: No immediate impact. The equipment is capitalized, not expensed.

Cash Flow Statement: Cash from Investing decreases by $100 (capital expenditure).

Balance Sheet: Cash decreases by $100. PP&E increases by $100. The Balance Sheet still balances.

Over the equipment's life, say 10 years with straight-line depreciation:

Income Statement: Depreciation expense of $10 per year reduces Operating Income and Net Income. Assuming a 25% tax rate, Net Income decreases by $7.50.

Cash Flow Statement: We start with Net Income (down $7.50). Add back depreciation ($10) because it's non-cash. Cash from Operations increases by $2.50.

Balance Sheet: Net PP&E decreases by $10 (accumulated depreciation). Retained Earnings decreases by $7.50 (from lower Net Income). Cash increases by $2.50 (from CFO). Assets decrease by $7.50 total, matching the decrease in Shareholders' Equity."

Concept 3: Working Capital

Working capital appears constantly in valuation and cash flow analysis.

What It Is

Working Capital = Current Assets - Current Liabilities

More commonly in finance:

Operating Working Capital = Accounts Receivable + Inventory - Accounts Payable

Why It Matters

Working capital represents the cash tied up in day-to-day operations.

If customers owe you money (AR), that's cash you don't have yet
If you have inventory sitting in warehouses, that's cash tied up in goods
If you owe suppliers (AP), that's cash you haven't had to pay yet

How Changes Affect Cash Flow

Increase in AR: Cash decreases (you sold goods but haven't collected cash)

Increase in Inventory: Cash decreases (you bought inventory with cash)

Increase in AP: Cash increases (you received goods but haven't paid yet)

Rule of thumb: Increases in current assets use cash. Increases in current liabilities provide cash.

Interview Question: What Happens to Cash Flow If Accounts Receivable Increases by $10?

Strong answer:

"If Accounts Receivable increases by $10, Cash from Operations decreases by $10.

The increase in AR means customers owe us more money than before. We recognized revenue (which increased Net Income), but we haven't collected the cash yet.

On the Cash Flow Statement, we start with Net Income (which included this revenue) and subtract the increase in AR to arrive at actual cash received."

Concept 4: Deferred Revenue

Deferred revenue is tricky. Get it right.

What It Is

Deferred revenue (or unearned revenue) represents cash received before the service is delivered.

Example: A software company sells a $120 annual subscription. The customer pays upfront in January. But the company can only recognize $10/month as revenue as the service is provided.

Balance Sheet Treatment

Deferred revenue is a liability. The company owes future service to the customer.

Income Statement Impact

Revenue is recognized over time as the service is delivered, not when cash is received.

Cash Flow Impact

Cash was received upfront. But Net Income doesn't reflect this yet (revenue recognized over time).

On the Cash Flow Statement: Increase in Deferred Revenue is added to Net Income in CFO—it represents cash received not yet in Net Income.

Interview Question: If Deferred Revenue Increases by $50, What Happens to Cash?

Strong answer:

"If Deferred Revenue increases by $50, Cash increases by $50.

Deferred Revenue is a liability that increases when customers pay us before we deliver services. We received $50 in cash, but we haven't recognized it as revenue yet—so it's not in Net Income.

On the Cash Flow Statement, we add this $50 to Net Income in Cash from Operations. It's cash we received but haven't yet earned through the P&L."

Concept 5: Goodwill and Impairment

Goodwill is critical for M&A accounting.

What Goodwill Is

Goodwill = Purchase Price - Fair Value of Net Identifiable Assets

When Company A acquires Company B for more than the fair value of B's tangible and identifiable intangible assets, the excess is recorded as Goodwill.

Example: Company A pays $500 million for Company B. Company B's identifiable assets are worth $350 million. Goodwill = $150 million.

Why Goodwill Exists

Acquirers pay premiums for:

Brand value
Customer relationships
Synergies
Growth potential
Other intangible value not separately identifiable

Goodwill Impairment

Goodwill isn't amortized (unlike other intangibles). Instead, it's tested annually for impairment.

If the acquired business is worth less than what was paid, goodwill is written down.

Income Statement impact: Impairment is a non-cash expense that reduces Net Income.

Cash Flow Statement: Impairment is added back in CFO (non-cash charge).

Balance Sheet: Goodwill decreases. Retained Earnings decreases.

Interview Question: How Does Goodwill Get Created?

Strong answer:

"Goodwill is created in acquisitions when the purchase price exceeds the fair value of the target's identifiable net assets.

For example, if a company pays $200 million to acquire a target with identifiable assets of $150 million, $50 million is recorded as Goodwill.

Goodwill represents the value of intangibles that can't be separately identified—things like brand reputation, customer loyalty, synergies, and assembled workforce.

Unlike other intangible assets, Goodwill is not amortized. Instead, it's tested annually for impairment. If the acquired business loses value, Goodwill is written down, creating a non-cash expense on the Income Statement."

Concept 6: Deferred Taxes

Deferred taxes confuse many candidates. Understanding the basics is sufficient.

Why Deferred Taxes Exist

Companies keep two sets of books:

GAAP books for financial reporting
Tax books for the IRS

These books often differ in timing. An expense might be recognized earlier for tax purposes than for GAAP purposes (or vice versa).

Deferred Tax Assets (DTAs)

DTAs arise when a company pays more taxes now than GAAP suggests.

Example: A company records a warranty expense on GAAP books today but can only deduct it for taxes when actually paid. The company pays more taxes today, creating a DTA—a future tax benefit.

Deferred Tax Liabilities (DTLs)

DTLs arise when a company pays fewer taxes now than GAAP suggests.

Example: A company uses accelerated depreciation for taxes but straight-line for GAAP. Lower taxable income today means fewer taxes paid, but this will reverse in the future. The DTL represents future taxes owed.

Interview Question: What's the Difference Between a Deferred Tax Asset and a Deferred Tax Liability?

Strong answer:

"Deferred taxes arise from timing differences between GAAP and tax accounting.

A Deferred Tax Asset represents future tax savings. It occurs when a company pays more taxes now than GAAP earnings suggest. For example, if a company accrues an expense for GAAP that isn't yet deductible for taxes, it pays more taxes today but will get a deduction in the future.

A Deferred Tax Liability represents future taxes owed. It occurs when a company pays fewer taxes now than GAAP earnings suggest. The most common example is accelerated depreciation—companies take larger tax deductions early, paying less taxes today but more in the future as depreciation reverses.

DTAs are assets because they represent future benefits. DTLs are liabilities because they represent future obligations."

Concept 7: Revenue Recognition

Revenue recognition principles affect when revenue appears on the Income Statement.

The Core Principle

Revenue is recognized when it is earned, not necessarily when cash is received.

Under ASC 606, revenue is recognized when:

A contract with the customer exists
Performance obligations are identified
The transaction price is determined
Price is allocated to performance obligations
Revenue is recognized as obligations are satisfied

Practical Implications

Product companies: Revenue recognized when goods are delivered and title transfers.

Service companies: Revenue recognized as services are performed.

Subscription companies: Revenue recognized over the subscription period.

Long-term contracts: Revenue recognized based on percentage of completion or at completion.

Interview Application

When analyzing companies, understand how they recognize revenue. Aggressive revenue recognition can inflate current earnings at the expense of future periods.

Concept 8: EBITDA

EBITDA isn't a GAAP measure, but it's everywhere in banking.

What It Is

EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization

Or: EBITDA = Operating Income + Depreciation + Amortization

Why Bankers Use It

EBITDA approximates operating cash flow before capital structure and capital expenditures.

Before Interest: Capital structure neutral—debt levels don't affect it
Before Taxes: Tax situation neutral—different rates don't affect it
Before D&A: Non-cash charges removed—approximates cash generation

Limitations

EBITDA ignores:

Capital expenditures (equipment must be replaced)
Working capital needs
Interest (which is a real cash expense for leveraged companies)
Taxes (also a real cash expense)

EBITDA is a proxy, not actual cash flow.

Interview Question: What's Better—EBITDA or Net Income?

Strong answer:

"Neither is universally better. They serve different purposes.

EBITDA is useful for comparing operating performance across companies with different capital structures and tax situations. It removes financing decisions and non-cash charges to focus on operational efficiency.

Net Income shows what actually accrues to shareholders after all expenses. It's the bottom line, reflecting real profitability.

For valuation, EBITDA is often preferred because it's capital structure neutral—you can compare companies regardless of how they're financed. For evaluating actual shareholder returns, Net Income matters more.

The best answer is: it depends on what you're trying to measure."

Concept 9: Capital Expenditures (CapEx)

CapEx is crucial for cash flow analysis and valuation.

What It Is

Capital expenditures are investments in long-term assets—property, plant, equipment, software, and other assets that will be used over multiple years.

Two Types

Maintenance CapEx: Spending required to maintain existing capacity. Replace worn-out equipment, maintain buildings.

Growth CapEx: Spending to expand capacity. Build new factories, open new locations.

Financial Statement Impact

Balance Sheet: CapEx increases PP&E (or other long-term assets).

Cash Flow Statement: CapEx appears as a use of cash in Cash from Investing.

Income Statement: No immediate impact. The asset is depreciated over time, creating future expense.

Why It Matters for Valuation

Free Cash Flow = Cash from Operations - CapEx

Companies that require heavy CapEx to maintain operations have less cash available for shareholders and debt holders.

Concept 10: Free Cash Flow

Free Cash Flow is the cash available after maintaining operations.

The Formula

Free Cash Flow (FCF) = Cash from Operations - Capital Expenditures

Or more precisely:

Unlevered FCF = EBIT × (1 - Tax Rate) + D&A - CapEx - Changes in Working Capital

Levered vs. Unlevered

Unlevered FCF (Free Cash Flow to Firm): Cash available to all capital providers (debt and equity). Used in enterprise value DCFs.

Levered FCF (Free Cash Flow to Equity): Cash available only to equity holders (after interest payments). Used in equity value DCFs.

Why FCF Matters

FCF is what actually accrues to investors. It's the cash available to:

Pay dividends
Repurchase shares
Pay down debt
Make acquisitions
Hold as cash

Profitable companies can still run out of cash if CapEx and working capital needs consume all operating cash.

Concept 11: Accrual vs. Cash Accounting

Understanding this distinction explains many accounting complexities.

Cash Accounting

Records transactions when cash changes hands.

Revenue recorded when cash received
Expenses recorded when cash paid

Simple but doesn't match economic reality for many businesses.

Accrual Accounting

Records transactions when economic activity occurs.

Revenue recorded when earned (not necessarily received)
Expenses recorded when incurred (not necessarily paid)

Why It Matters

GAAP requires accrual accounting. The Income Statement shows accrual-based earnings. The Cash Flow Statement reconciles these earnings to actual cash.

The difference between Net Income and Cash from Operations largely reflects accrual vs. cash timing differences.

Interview Example

A company ships $100 of goods on December 31 but doesn't receive payment until January 15.

Accrual: $100 revenue in December (when earned) Cash: $100 cash in January (when received)

The Income Statement (accrual) shows December revenue. The Cash Flow Statement shows the AR increase reduces CFO—we recognized revenue but haven't collected cash.

Concept 12: The Inventory Cycle

Inventory accounting affects cost of goods sold and margins.

How Inventory Flows

Raw materials are purchased (Balance Sheet: Inventory increases)
Materials become work-in-process (still Inventory)
Finished goods are completed (still Inventory)
Goods are sold (Inventory decreases; COGS recorded on Income Statement)

Inventory Valuation Methods

FIFO (First In, First Out): Oldest inventory costs flow to COGS first.

LIFO (Last In, First Out): Newest inventory costs flow to COGS first.

Weighted Average: Average cost flows to COGS.

Why It Matters

In inflationary environments:

LIFO: Higher COGS, lower Net Income, lower taxes
FIFO: Lower COGS, higher Net Income, higher taxes

The choice affects reported profitability and comparability across companies.

Concept 13: Stock-Based Compensation

Stock-based compensation is controversial in valuation circles.

What It Is

Companies compensate employees with stock options, restricted stock units (RSUs), and other equity awards.

Income Statement Treatment

Stock-based compensation is expensed on the Income Statement—it reduces Net Income.

Cash Flow Treatment

Stock-based comp is a non-cash expense. It's added back in Cash from Operations (similar to depreciation).

The Controversy

Some argue SBC is a real cost—it dilutes shareholders. Others argue it's non-cash and should be added back for valuation.

The prevailing view: SBC is a real cost that should reduce valuation metrics. But it's non-cash, so it's added back when calculating cash flow.

Interview Question: Is Stock-Based Compensation a Real Expense?

Strong answer:

"Yes, stock-based compensation is a real expense, even though it's non-cash.

SBC compensates employees with equity instead of cash. If the company didn't issue stock, it would need to pay higher cash salaries. The expense represents real value transferred to employees.

Additionally, SBC dilutes existing shareholders. New shares issued to employees reduce the ownership percentage of existing holders.

For cash flow purposes, SBC is added back because no cash was spent. But for valuation purposes—particularly when calculating metrics like adjusted EBITDA—many analysts treat SBC as a real expense and don't add it back. This is especially important for tech companies where SBC can be substantial."

Concept 14: Operating Leases vs. Finance Leases

Lease accounting changed significantly with ASC 842. Understand the basics.

Operating Leases (Under New Rules)

Balance Sheet: Right-of-use asset and lease liability both recorded
Income Statement: Lease expense (straight-line)
Cash Flow Statement: Principal portion in CFO, interest portion in CFO

Finance Leases

Balance Sheet: Asset and liability recorded (larger liability initially)
Income Statement: Depreciation + interest expense (front-loaded)
Cash Flow Statement: Principal in CFF, interest in CFO

Why It Matters

Under old rules, operating leases were off-balance sheet. Companies like airlines and retailers had enormous unrecorded obligations.

New rules (ASC 842) require all leases on the Balance Sheet. This increased reported debt substantially for lease-heavy industries.

Concept 15: Debt vs. Equity

Understanding capital structure is fundamental.

Key Differences

Characteristic	Debt	Equity
Repayment	Required (principal + interest)	Not required
Priority in liquidation	Higher	Lower
Tax treatment	Interest is tax-deductible	Dividends are not
Control	Lenders have covenants	Shareholders have voting
Cost	Generally lower	Generally higher
Risk to investor	Lower (contractual)	Higher (residual)

Why It Matters

Capital structure affects:

Valuation: Enterprise value includes debt; equity value doesn't
Risk: More debt = more financial risk
Returns: Leverage amplifies returns (both positive and negative)
Flexibility: High debt limits future options

Interview Question: Why Might a Company Prefer Debt Over Equity?

Strong answer:

"Companies prefer debt over equity for several reasons.

First, interest is tax-deductible. Debt has a lower after-tax cost than equity because the government effectively subsidizes interest payments.

Second, debt doesn't dilute ownership. Existing shareholders maintain their percentage of the company.

Third, debt is typically cheaper than equity. Lenders accept lower returns because they have priority claims and contractual protections.

However, debt has drawbacks. It requires mandatory repayment regardless of company performance. It adds financial risk—the company must make payments even in downturns. And it comes with covenants that restrict flexibility.

The optimal mix depends on the company's stability, asset base, growth plans, and risk tolerance."

Concept 16: Treasury Stock

Treasury stock represents shares a company has repurchased.

What It Is

When a company buys back its own shares, those shares become treasury stock.

Balance Sheet Treatment

Treasury stock reduces Shareholders' Equity. It's recorded as a negative number (contra-equity).

Why Companies Repurchase

Return cash to shareholders
Signal that shares are undervalued
Offset dilution from stock-based compensation
Improve per-share metrics (fewer shares outstanding)

Interview Question: How Does a $50 Share Buyback Affect the Three Statements?

Strong answer:

"A $50 share buyback affects the statements as follows:

Income Statement: No impact. Buybacks don't flow through the P&L.

Cash Flow Statement: Cash from Financing decreases by $50. Buybacks are recorded as a use of cash in CFF.

Balance Sheet: Cash decreases by $50. Treasury Stock (contra-equity) increases by $50, reducing Shareholders' Equity by $50. The Balance Sheet still balances—Assets and Equity both decrease by $50."

Concept 17: Minority Interest

Minority interest (or non-controlling interest) appears in consolidated financials.

What It Is

When a company owns more than 50% but less than 100% of a subsidiary, it consolidates 100% of the subsidiary's financials but doesn't own 100%.

Minority interest represents the portion owned by others.

Balance Sheet Treatment

Minority interest is recorded in the equity section (sometimes between liabilities and equity). It represents outsiders' claim on subsidiary assets.

Income Statement Treatment

100% of subsidiary revenue and expenses are consolidated. At the bottom, "Net Income Attributable to Non-Controlling Interest" is subtracted to show the parent's share.

Enterprise Value Treatment

Minority interest is added to Enterprise Value. Why? Because you're valuing the entire enterprise (100% of the subsidiary), including the portion you don't own.

Concept 18: Basic vs. Diluted Shares

Diluted shares matter for valuation.

Basic Shares

The actual number of common shares currently outstanding.

Diluted Shares

Basic shares plus the potential shares from:

Stock options (using Treasury Stock Method)
Convertible securities
Restricted stock units
Warrants

Treasury Stock Method

For options, assume they're exercised. The company receives exercise proceeds and uses them to repurchase shares at the current market price. Net new shares are added to the count.

Example: 1 million options at $20 strike. Stock price is $50.

Shares issued upon exercise: 1 million
Proceeds: $20 million
Shares repurchased: $20M / $50 = 400,000
Net dilution: 600,000 shares

Why It Matters

Diluted shares outstanding is used to calculate:

Diluted EPS
Equity value (stock price × diluted shares)

Always use diluted shares for valuation. Basic shares understate the true claim on equity.

Concept 19: Retained Earnings

Retained earnings connect the Income Statement to the Balance Sheet.

What It Is

Retained Earnings = Cumulative Net Income - Cumulative Dividends

It represents profits that have been reinvested in the business rather than distributed to shareholders.

How It Changes

Increases: Net Income

Decreases: Dividends, Net Losses

Balance Sheet Location

Retained Earnings is part of Shareholders' Equity.

The Connection

When Net Income is $100 and no dividends are paid:

Retained Earnings increases by $100
Shareholders' Equity increases by $100
Assets must also increase by $100 (usually Cash, through CFO)

This is how Net Income flows from the Income Statement to the Balance Sheet.

Concept 20: The Cash Flow Statement in Detail

Master the Cash Flow Statement structure.

Cash from Operations (CFO)

Starts with: Net Income

Adjusts for non-cash items:

Add: Depreciation and amortization
Add/Subtract: Deferred taxes
Add: Stock-based compensation
Add: Goodwill impairment
Add/Subtract: Other non-cash items

Adjusts for working capital changes:

Subtract: Increase in Accounts Receivable
Subtract: Increase in Inventory
Add: Increase in Accounts Payable
Add: Increase in Deferred Revenue

Cash from Investing (CFI)

Capital expenditures (use)
Acquisitions (use)
Divestitures (source)
Purchases of investments (use)
Sales of investments (source)

Cash from Financing (CFF)

Debt issuance (source)
Debt repayment (use)
Equity issuance (source)
Share buybacks (use)
Dividends paid (use)

The Reconciliation

Beginning Cash + CFO + CFI + CFF = Ending Cash

Ending Cash on the Cash Flow Statement = Cash on the Balance Sheet

Quick Reference: Common Interview Questions

Rapid-Fire Answers

Q: How are the three statements linked? A: Net Income flows to Retained Earnings (BS). Net Income starts CFO. Change in Cash (CFS) equals change in Cash (BS).

Q: What happens if depreciation increases by $10? A: Net Income decreases by $7.50 (assuming 25% taxes). CFO is unchanged (lower NI offset by higher D&A add-back). Cash unchanged.

Q: What happens if inventory increases by $10? A: No Income Statement impact. CFO decreases by $10. Cash decreases by $10.

Q: Is interest expense or interest income included in Enterprise Value calculations? A: Neither directly. EV uses EBIT or EBITDA (before interest). But net debt (debt minus cash) is added/subtracted.

Q: What's the difference between cost of goods sold and operating expenses? A: COGS are costs directly tied to production (materials, labor, manufacturing). OpEx are costs not directly tied to production (sales, admin, R&D).

The Bottom Line

You don't need to know every GAAP rule. You need to know how financial statements work together and why.

These 20 concepts cover what actually appears in interviews. Know how transactions flow through all three statements. Understand why non-cash charges matter. Be able to trace the connections.

Accounting is the foundation. Valuation, modeling, and deal analysis all build on it. Get these concepts right, and the rest becomes much easier.